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Horizon's Hostile Bid for DepoMed Is Too Low

After being stonewalled by DepoMed's(NASDAQ:DEPO) board of directors, Horizon Pharma plc(NASDAQ:HZNP) has gone public with a bid to acquire DepoMed for $3 billion.

Horizon Pharma's public announcement could kick-start DepoMed's management into negotiations, or lead to DepoMed making a stronger and more vocal argument to investors on why it should retain its independence. Either way, Horizon Pharma's current bid likely undervalues DepoMed.

Who are these guys?Neither of these companies is very well known to investors, but both are intriguing businesses that are minting money thanks to a business model that involves acquiring underperforming FDA approved therapies and reinvigorating sales. Horizon Pharma is the bigger of the two companies, with a $5.2 billion market cap, and $113 million in first-quarter sales.

Horizon Pharma's success stems from Vimovo, a pain reliever it acquired in 2013 for $35 million that limits ulcers in arthritis patients. At the time of its acquisition, Vimovo had just $20 million in annual sales, but thanks to Horizon Pharma's relaunch efforts, Vimovo has become a far better selling therapy, with $163 million in sales last year. In the wake of Vimovo's success, Horizon Pharma also acquired Actimmune and Pennsaid last fall, and bought Hyperion Therapeutics for $1.1 billion this past spring.

Across all of these medicines, Horizon Pharma expects to deliver sales of between $590 million and $610 million this year, and that has industry watchers projecting EPS of $1.22 in 2015. DepoMed is smaller than Horizon Pharma, but it has a similar business model that could help it close the gap.

DepoMed markets three fast-growing medicines, including the shingles pain therapy Gralise, the breakthrough pain medication Lazanda, and the migraine drug Cambia. The gem in DepoMed's portfolio, however, is Nucynta, an opioid pain medication that DepoMed acquired from Johnson & Johnson for $1.05 billion earlier this year.

In April, DepoMed relaunched Nucynta with a 275 person sales force and a 44% price hike. The company thinks this will allow it to deliver total companywide sales of between $310 million and $335 million this year.

Is $3 billion enough?If DepoMed leverages its existing relationships with pain specialists, and boosts Nucynta's market share beyond current levels, Nucynta could prove to be a big moneymaker that isn't fully factored into Horizon Pharma's $3 billion offer. Currently, the original formulation of Nucynta accounts for just 0.3% of the short-acting opioid market, and the longer-lasting Nucynta ER represents just 1.5% of the long-acting opioid market. Because DepoMed pegs sales in the short-term opioid market at $7.1 billion and sales in the long-term opioid market at $5.5 billion annually, small gains in market share could translate into significant revenue growth for DepoMed, especially because the total opioid market is forecast to grow by 5% per year through 2018.

Nucynta's market opportunity is a big reason why industry analysts think that DepoMed's sales will jump to $484 million next year, which is 44% higher than the top-end of DepoMed's 2015 sales guidance. That's significant revenue growth, but Nucynta's impact on the bottom line may be more important to a potential acquirer.

Analysts expect DepoMed to report EPS of $0.29 this year, but DepoMed's ability to leverage Nucynta's sales growth against its fixed costs has investors thinking that DepoMed's EPS will surge to $1.20 in 2016. Although there's no guarantee that Nucynta will be as successful as these forecasts suggest, these projections could mean that Horizon Pharma is willing to increase its offer, especially since Horizon Pharma could eliminate a lot of overlapping costs associated with selling its own pain medicines. DepoMed's growth could also encourage other suitors to come knocking.

Looking forwardDepoMed has firmly rejected Horizon Pharma's overture, but DepoMed's board has a fiduciary responsibility to evaluate offers, so anything could still happen. Personally, I'm a fan of both DepoMed and Horizon Pharma's business model, and believe that both could offer investors significant growth in the future. For that reason, regardless of how this deal plays out, I think both of these companies could be buys.

Todd Campbell owns shares of DepoMed. Todd owns the equity research firm E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool recommends Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

Todd has been helping buy side portfolio managers as an independent researcher for over a decade. In 2003, Todd founded E.B. Capital Markets, LLC, a research firm providing action oriented ideas to professional investors. Todd has provided insight to a variety of publications, including SmartMoney, Barron's, and CNN/fn.
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